Growth in Europe – The key is to reallocate resources

29 February 2012

This post is archived. Opinions expressed herein may no longer represent my current views. Links, images and other media might not work as intended.

After several years in recession, stagnation or anemic expansion, characterized by massive cuts in public and private spending, the issue of “growth” has naturally perhaps been brought to the foreground. The question that every political group seeks to answer is how do we recover from this crisis? The views on the issue are of course vastly diverse, reflecting the ideological differences between politicians; yet there is a common belief shared by all parties, which is that fiscal consolidation (austerity) is not a solution per se – everybody knows that, even if they are not wiling to accept it at this stage for political or tactical reasons.

When it comes to growth, my view is that we first need to clarify our framework of ideas, before proceeding into the actual discussion. The reason I say that is because we often attach too much attention to the macroeconomic figures that show economic growth, without however looking into the quality of that economic drive. In the eurozone this has over the last ten years led to large scale malinvestment, perverse incentives and undesirable outcomes as the bubbles in the European periphery demonstrated (Greece, Ireland, Spain etc.) and as the persistently high levels of unemployment always point out.

This experience must teach us a lesson: that we can no longer afford to exercise inflationist practices that exacerbate economic instability. Growth must derive from a self sustainable, endogenous engine, not from political alchemy. This can only be achieved by reforming the state (from local to supranational) while facilitating the reallocation of resources from non-tradable to tradable sectors.

Take Greece as an example to grasp my point: the country experienced an unprecedented capital flow bonanza when it gained accession to the eurozone. This tsunami of capital allowed Greek banks to issue relatively cheap credit and the Greek state to borrow at low interest rates. As such the economic growth in Greece was driven by a sharp increase in consumption and several investments in infrastructure (many in projects for the Olympic Games, that are now useless). Greece experienced growth rates that were significantly higher than other core European economies like Germany. Yet all that growth was purely artificial and was definitely going to lead to a sharp downturn one way or other. The reason is that the structural malignancies of the Greek economy remained in place. Namely the persistently negative balance of payments, the cumbersome bureaucracy, the ridiculously ineffective tax collection mechanisms, the shaky banking system, the problematic real economy. These were all magnified by inflation, which was the natural outcome of the credit hog ever since the early 2000’s.

Today we all know where those dynamics brought us to. If we are prudent enough we will simply not repeat such policies and instead look for real reform and sustainable growth. This is now what Greece needs (and Greece is used as an example for most eurozone countries). To correct all the structural flaws of the economy, eliminate bad government failures (interventions), allowing for sustainable investments and growth in the production and consumption of real goods and services. The key to growth in Europe is to reallocate resources and live within our means.